Antitrust - A Monopolist Does Not Violate the Antitrust Laws by Using an Exclusive Distributor: E&L Consulting, Ltd. v. Doman Indus. Ltd., No. 05-1751-cv (2d Cir. Dec. 15, 2006)
The United States Court of Appeals for the Second Circuit has affirmed a district court’s decision to dismiss an antitrust suit brought against a lumber supplier by its former distributor. The case is E&L Consulting, Ltd. v. Doman Industries, Ltd.,
No. 05-1751-cv (2d Cir. Dec. 15, 2006), and it involves the issue of whether a monopolist (in this case a company with 95 percent market share) violates the antitrust laws by using an exclusive distributor.
The Market for Green Hem-Fir Lumber
Green hem-fir lumber is a durable, but inexpensive, wood that is often used in homebuilding. Doman Industries, a Canadian corporation, supplies 95 percent of the green hem-fir lumber used in the northeastern United States. For fifteen
years Doman distributed its lumber through E&L Consulting. E&L accepted delivery (but not ownership) of the lumber at its facility in New York and sold the lumber either by itself or through two sub-distributors. Doman set
the prices and paid commissions to E&L.
In 1998, Doman stopped dealing with one of E&L’s sub-distributors. To replace the sub-distributor, Doman contracted with Sherwood Lumber Corp. to distribute lumber in the area formerly served by the sub-distributor. Doman
prohibited E&L from selling any lumber in Sherwood’s territory. In 2003, Doman ended its relationship with the other sub-distributor and gave Sherwood exclusive distribution rights in that territory as well. Doman permitted
Sherwood to purchase its lumber outright at a significant discount, while refusing to give E&L the same arrangement. Finally, in 2004 Doman terminated its agreement with E&L and gave Sherwood exclusive distribution rights
throughout the entire northeastern United States.
E&L’s Antitrust Suit
E&L alleged that Doman’s market share made it the only commercially feasible supplier of green hem-fir lumber. E&L also alleged that other types of lumber were not adequate substitutes for green hem-fir. E&L claimed
that Doman established barriers to other competitors entering the market by reserving all of the space on the only ocean shipping line transporting lumber from Canada to New York, leaving other suppliers unable to ship lumber to
the market. E&L also alleged that Sherwood abused its position as Doman’s exclusive distributor in two ways. First, E&L alleged that Sherwood raised prices by 20 percent or more once it obtained exclusive distribution
rights. Second, E&L claimed that Sherwood required that any customer who wanted green hem-fir lumber also had to purchase Sherwood’s “finished wood products.” E&L claimed that this arrangement damaged
one of E&L’s subsidiaries that produced “finished wood products.”
E&L filed a five-count antitrust suit against Doman and Sherwood in the United States District Court for the Eastern District of New York. E&L alleged violations of Sections 1 and 2 of the Sherman Act, an illegal tying scheme,
and violations of Section 7 of the Clayton Act and Section 2 of the Robinson-Patman Act. The district court dismissed the action in its entirety for failing to state a claim.
The Second Circuit Affirms the Dismissal
The Second Circuit acknowledged that an exclusive distributorship is a vertical restraint on trade. But it reasoned that every commercial agreement restrains trade to some extent and that an exclusive distributorship arrangement
is presumptively valid unless a plaintiff can show actual adverse effects on competition. The court also noted that Doman already had monopoly power over the green hem-fir lumber market because it had a 95 percent market share (E&L
did not allege that Doman’s market share was itself an illegal monopoly). Doman could have created an in-house distribution system with the same monopoly power that Sherwood was alleged to possess, and that system would have
restricted the output of green hem-fir lumber at least as much as did its arrangement with Sherwood. In fact, the court noted that a monopolist would prefer multiple competing buyers for its product unless an exclusive distributorship
provides some other benefits for it. The court characterized E&L’s Section 1 claim a “run-of-the-mill exclusive distributorship controversy” where a former distributor tries to protect its position with its
former supplier. The court rejected E&L’s Section 2 claim for the same reason.
The court also rejected the argument that Doman’s reservation of all of the shipping capacity on the only ocean line delivering lumber to the market supported E&L’s Section 2 claim. A supplier does not violate the
antitrust laws by fulfilling demand for its products, and if Doman required and used all available capacity to ship its lumber there could be no antitrust violation. E&L failed to allege that Doman reserved excess capacity or
took any other actions as part of a scheme to monopolize the market.
As for the remaining claims, the court held that E&L had failed to allege adequate facts to support its tying claim because “finished wood products” covered a broad range of goods and E&L failed to specify which
products had been tied to the sale of green hem-fir lumber. The court also quickly dismissed E&L’s claims under Section 7 of the Clayton Act (which applies to mergers) and Section 2 of the Robinson-Patman Act (which does
not apply to sales agents like E&L).
Conclusion
The court resolved this case on the simple economic principle that only one monopoly profit can be created in a single vertical enterprise. Doman already had all the monopoly power it could acquire by supplying 95 percent of the
green hem-fir lumber to the geographic market alleged by E&L. It could not create any additional monopoly power by using an exclusive distributor to sell its products. Doman could have hired dozens of distributors and permitted
them to compete with one another for sales. But as long as Doman maintained the power to set the prices the distributors could charge (as it did for E&L), Doman would still have monopoly power and consumers would be no better
off than they would be with a single exclusive distributorship.
The court noted that exclusive distributorship arrangements are presumptively legal. The court acknowledged that certain exclusive distributorship arrangements may violate the antitrust laws, but it added that the plaintiff in such
a case must show some additional conduct by the supplier and/or distributor that makes the arrangement unreasonable. For example, the court cited a case in which a pharmaceutical manufacturer and the supplier of the active ingredient
in the drug in question used their temporary monopoly created by the FDA approval process to mislead potential competitors about the nature of their relationship and dissuade other companies from producing generic alternatives. But
E&L failed to allege any conduct that would render the relationship between Doman and Sherwood anything other than an ordinary exclusive distributor arrangement. Given the facts alleged by E&L, the court could not find the
exclusive distributorship unreasonable from a competition standpoint.
E&L’s claims ring somewhat hollow because it was at one point essentially an exclusive distributor for Doman, and Doman created the downstream market in which E&L participated. Over the years, Doman transferred its
business away from E&L and its sub-distributors and moved it to Sherwood. E&L was obviously disappointed by its own lost market share, but just because E&L was replaced as a distributor does not mean that Doman harmed
competition by selling its products through a different exclusive distributor.